The Financial Times’ Tracy Alloway has a piece on the state of the repurchase, or repo, market, and what she finds is a little unsettling.
The repo market allows parties to pledge securities as collateral in order to gain access to short-term loans. For example, a hedge fund could pledge U.S. Treasury bonds it owns as collateral in exchange for capital to use for another transaction.
Alloway reports that institutions and REITs have replaced banks as the biggest players in the repo market:
“What remains of the $US4.2tn market is increasingly being taken up by non-bank entities such as real estate investment trusts (Reits), mutual funds and hedge funds … The growing use of repo has been particularly marked among Reits, which have overtaken banks and broker-dealers as the largest borrowers in the market, according to Federal Reserve data.”
Alloway adds that, “[i]ndustry participants say there is ample anecdotal evidence that other types of big investors are lending out more of their assets to generate greater returns.”
Last year, the FT highlighted potential risks financial markets could face amid a shrinking repo market. Alloway also notes that a sudden loss of confidence from lenders in the repo market ahead of the 2008 financial crisis “proved destabilizing.”
With interest rates low and markets experiencing less volatility than they have in decades, investors are seeking returns wherever and however they can find them, commonly known as the “search for yield.”
As the composition of the repo market changes, the question is: what happens next?
(via Reformed Broker)